Fitch Assigns 'A+' to Catholic Healthcare West Bond Offering

Fitch Ratings has assigned an ‘A+’ rating to Catholic Healthcare West’s (CHW) upcoming $1.2 billion series 2007 bonds. In addition, Fitch affirms the ‘A+’ rating on approximately $2.9 billion in outstanding bonds (listed below). The Rating Outlook is Stable.

The 2007 bonds are expected to be issued through multiple issuers in California, Arizona and Nevada. CHW expects to issue a total of $675.6 million bonds through the California Statewide Communities Development Authority as 7-day or 35-day insured auction rate securities. The bonds are expected to be issued in twelve separate series (series 2007 A-L) each of which will be insured by Assured Guaranty (AGIC), CIFG Assurance (CIFG), Financial Guaranty Insurance Company (FGIC), Financial Security Assurance (FSA) or MBIA Insurance (MBIA). The broker-dealers agent on each of the series 2007A-L bonds will be either Citigroup, Inc or J.P. Morgan, Inc. In addition, CHW expects to issue $449.6 million of uninsured, conventional fixed rate bonds with approximately $171 million to be issued through the Maricopa County, AZ Industrial Development Authority, $184.3 million to be issued through the City of Henderson, NV and $94.2 million to be issued through the City of Reno, NV.

Proceeds from the series 2007 bonds will be used to refund a total of $389.1 million of bonds outstanding (listed below); repay a taxable line of credit incurred to finance the merger with St. Mary’s Medical Center in Reno; fund approximately $670 million of various capital projects throughout the system and pay for the costs of issuance including the bond insurance premium. Upon the issuance of the series 2007 bonds, CHW total debt outstanding will increase to approximately $4 billion. The uninsured fixed rate bonds are expected to price the week of April 2nd while the insured auction rate securities are expected to be priced the week of April 23rd. The series 2007 bonds will be priced through negotiation by Citigroup and JP Morgan as co-senior managers.

The ‘A+’ rating reflects CHW’s excellent management practices, sustained operating improvement, the system’s geographic diversity and profit dispersion and locations in growing markets in and outside of California. Fitch believes CHW’s management practices have been instrumental in the organization’s year over year improvement since fiscal 2001. Management has increased accountability at individual hospitals, executed on operating budgets, made successful strategic investments and been among the leaders in using information technology to drive improved operating efficiencies. Moreover, increased patient volume, focused capital investment, and growth in market share in certain markets have contributed to the system-wide improvement. Operating income (exclusive of the loss on early extinguishment of debt) was a robust $284.3 million in fiscal 2006, marking the fifth consecutive year of improved operating results. Operating margin (based on consolidated audited financial statements) improved to 4.2% in fiscal 2006 compared to 3.3% and 2.4% in fiscal years 2005 and 2004, respectively. Through the six month interim period ended Dec. 31, 2006, operating and excess margins were 3.8% and 6.9%, respectively.

Improved operating profitability and solid investment returns improved CHW’s unrestricted cash and investment position to $2.8 billion at Dec. 31, 2006 from $2.7 billion at June 30, 2006. Days cash on hand dipped slightly to 165.4 at Dec. 31, 2006 from 174.5 at June 30, 2006 due to a solid growth in patient volumes. As provided by the bankers, pro-forma maximum annual debt service increases to $235 million from $208.7 million with the issuance of the series 2007 bonds. Coverage of historical pro-forma maximum annual debt service (MADS) in fiscal 2006 slips to 3.4 times (x) from 3.9x using prior MADS.

CHW facilities are located throughout California, Arizona and Nevada. They are strategically located in high growth markets in all three states, with leading positions in many markets and profit dispersion among the regions. Effective January 1, 2007, the 380-bed Saint Mary’s Regional Medical Center (SMRMC) in Reno, NV was merged into the CHW system. In 2004, SMRMC had a 30% market share in the Reno total service area behind Washoe Medical Center with a leading 56% market share. Although the merger is mildly dilutive, SMRMC’s contribution to system results should improve as the benefits of being part of the CHW system are realized in areas such as managed care contracting, supply chain management and revenue cycle management. Fitch believes the merger compliments CHW’s strategic and mission goals and will provider further revenue and geographic dispersion.

Primary credit concerns include CHW’s extensive capital plan, a relatively heavy debt burden and rising bad debt expense. CHW’s sizable capital plan budget, which has been updated at $8.8 billion over the 10 year period (Fiscal 2007-2016), will be used to construct new and replacement facilities in its high growth markets, fund routine capital expenditures, address seismic requirements, expand CHW’s outpatient settings, and enhance technological capabilities. CHW expects to fund the total capital budget through a combination of additional debt, operating cash flow, investment earnings and fundraising. Management has stated that future projects will be evaluated in part on the expected rate of return on invested capital and that the scope of future capital spending is dependent on the system’s level of profitability.

CHW’s debt burden is relatively high as compared to Fitch’s ‘A’ median. Pro-forma cash-to-debt upon closing of the series 2007 issue will weaken to approximately 68.4% at Dec. 31, 2006 from 82.7% and is below Fitch’s 2006 ‘A’ median of 111.1%. Pro-forma debt-to-capitalization rises to a high 55.3% at Dec. 31, 2006 and compares unfavorably to Fitch’s ‘A’ median of 41.7%. However, Fitch notes that pro-forma MADS is a moderate 3.2% of total revenue through the six month ended Dec. 31, 2006 and is in line with Fitch’s 2006 ‘A’ median of 3.2%. CHW’s level of bad debt expense continues to increase and reflects a rising uninsured and under-insured population. In fiscal 2006, bad debt as a percentage of total revenues equaled 8.1% which is up from 5.4% in fiscal 2002. Fitch believes that CHW is vulnerable to governmental funding cuts, especially from Medi-Cal, which covers 14% of CHW’s patient volume.

The Stable Outlook is based on Fitch’s belief that CHW can generate further operational improvement given management’s track record of successful plan implementation and its strategic growth initiatives. While CHW’s sizeable capital plan may constrain the rate of liquidity growth, management’s disciplined capital spending model should produce improved bottom line performance. In addition, Fitch believes the system’s investment in information technology will allow management to extract greater clinical and operational efficiencies throughout the system.

In conjunction with the series 2007 bond issue, CHW expects to enter into various floating-to-fixed rate swaps to effectively convert $400 million of the auction rate securities to a synthetic fixed rate obligation. Moreover, CHW will terminate $300 million of total return swaps related to the series 2004B bonds. Pro-forma total notional amount of CHW’s swap portfolio will be $1.3 billion with the counterparties being Citigroup, JP Morgan and Bank of America, all of whom are rated ‘AA-’ or higher by Fitch.

CHW is a not-for-profit Catholic health system with 42 total healthcare facilities, 36 of which are located in California, three in Arizona, and three in Nevada. Total revenue in fiscal 2006 was $6.7 billion. CHW covenants to disclose audited annual financial statements and quarterly results to bondholders. CHW’s disclosure is one of the best in Fitch’s portfolio. Quarterly financials are reviewed by CHW’s auditor and include an income statement, balance sheet, and cash flow statement. In addition, management hosts quarterly investor calls and posts all financial information on its website at www.chwhealth.org.